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European bond ETFs – tracking error and the sovereign debt crisis

The First International Moscow Finance Conference 2011. European bond ETFs – tracking error and the sovereign debt crisis. M. Drenovak , B. Urosevic and R. Jelic Discussed by: Sergey Gelman , ICEF, Higher School of Economics, Moscow. Summary (I).

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European bond ETFs – tracking error and the sovereign debt crisis

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  1. The First International Moscow Finance Conference 2011 European bond ETFs – tracking error and the sovereign debt crisis M. Drenovak, B. Urosevic and R. Jelic Discussed by: Sergey Gelman, ICEF, Higher School of Economics, Moscow

  2. Summary (I) • Studies differences in performance of in-kind and synthetic ETFs using different measures of tracking errors (TE) • About 3 years of data, 31 fund • Methodology: 4 types of tracking error measurement, panel regressions for active TE and standard TE

  3. Summary (II) Results: • Substantial discrepancy between return level and cointegration based measures on one side and correlation based measures on the other side: synthetic perform better according to former and worst according to latter • Positive relationship of TE and volatility, maturity and CDS rates of underlying is confirmed • TE grew with the crisis

  4. Comments (I) • An interesting paper, raises a number of issues • Is synthetic implication unique to FI-ETFs? • ETF market • ETFs are traded at a stock exchange at market prices • Fund managers publish NAV, but buy back at NAV only very large lots (50000 units) • Deviation of the ETF price from index • (see Elton et al. 2002)

  5. Comments (II) • Analyze both sources of deviations. For the first • Look at market depth • Volume • Creations/deletions • Different types of ETFs track different indices – not a very fair comparison (may be its not physical vs. synthetic). Seems more adequate: • Sharpe ratio (or SR improvement compared to underlying) • Hedging performance

  6. Comments (III) • Lyxor seems to be an actively managed fund. Relate to literature on comparison of active vs. passive • Bit more info on swap agreements: what are the costs? • Different types of tracking errors address different investors’ questions: TE1 – how much do I earn (compared to replicating the index myself), TE2, TE4– is it an appropriate hedging instrument? • Btw., can this questions be answered directly?

  7. Comments (IV) • TE3 should be discarded in case of non-zero constant and non-unity slope • Panel regression – autocorrelation issue • Cointegration: is there a trend (or constant)?

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